Our Co-Heads of Investments discuss whether the financial markets’ substantial gains following last autumn’s ‘Fed pivot’ left investors smug amid potential dangers.
Observations: Are Investors Too Complacent?
Adam Sparkman
Welcome to this quarter’s observations and global equities and fixed income. I’m Adam Sparkman, client portfolio manager with Thornburg Investment Management. Today I’m joined by Jeff Klinghofer and Ben Kirby, our co-heads of investment for Ben and Jeff. Well Ben and Jeff, I think maybe I’ll start off with a question for both of you. Really, across global equity markets, we saw a continuation in the first quarter of the strong rally from 2023.
I think if you couple that with higher-than-expected inflation, the Federal Reserve doesn’t seem like they’re in any major hurry to start cutting interest rates. Jeff, When I look at fixed income, it seems like absolute yields remain at pretty attractive levels, but credit spreads continued to grind lower throughout the first quarter. Given the current set up, do you think that investors are maybe a little bit too complacent or are investors justified with the bullishness that we’re currently seeing?
Jeff Klingelhofer
Yeah, I think it’s really the question that is on every market maker’s mind. I think what we’ve seen is you’re absolutely right, GDP and GDP, some very high-level metrics suggest that the economy continues to grow very well. High level metrics suggest the consumer continues to be in a very good position. We continue to see relatively low unemployment prints, strong labor market. Everything feels good on the surface. The challenge is and I think the crux of your question is, when you peel back the onion a little bit, maybe there are some warning signs that the market is broadly ignoring at this point.
So, let’s focus on the consumer for one second. Yes, the employment market remains very, very strong and consumers continue to have that stockpile of some excess savings, but they’re spending it down.
And you couple that with they’re taking on more debt, they’re defaulting on that debt at a higher level. And that just doesn’t jive with the consumer. That’s as strong as maybe markets are suggesting. And I think we see that at all sorts of levels. Corporations in their balance sheet, we see the governments and their continued spending habits. So I do think my answer to the question is probably the market is a little bit too complacent, especially in the world of fixed income, where one should be focusing more on the downside protection versus just continuing to reach for yield and total return.
Adam Sparkman
So, Ben, how about on the equity side?
So, I think there is some complacency, but there’s also a lot of things that have gone right. So, Jeff alluded to GDP were growing at about 2.4% right now. Look, back in August of 2023, expectations for growth in 2024 were 60 basis points. So, there’s been a lot of upward revisions and growth expectations. And a year ago, inflation was 5% and today it’s about 2.8% on core PCE. So, I think there has been some real genuine progress in the economy.
Trailing earnings growth on the S&P 500 is 0% and forecast growth is about 10%. So, I think you could argue that we’ve already had a soft landing in earnings and that we’re actually re-accelerating as we look out later into the year. That said, there is a complacency again, because the S&P is trading at 21 times earnings. Even the equal weighted S&P is at about 17 times earnings.
Both of those are above long-term averages, especially the market cap weighted is in the top decile of long-term valuations. So, you know, when you consider earnings growth, maybe some of that is justified. But the fact is valuation is a terrible timing indicator. It indicates long term returns might be less attractive than they have been historically. But in the next 12 months, it may not have a very strong predictive power.
Important Information
The views expressed are subject to change and do not necessarily reflect the views of Thornburg Investment Management, Inc. This document is for informational purposes only and does not constitute a recommendation or investment advice and is not intended to predict the performance of any investment or market. It should not be construed as advice as to the investing in or the buying or selling of securities, or as an activity in furtherance of a trade in securities.
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